Get back to basics with VCTs

Susan McDonald, chairman of McDonald Glencross tells MoneyWeek where she'd put her money now.

Susan McDonald, chairperson of McDonald Glencross, which recently launched the Neptune-Calculus Income and Growth VCT, tells MoneyWeek where she'd put her money now.

Investors have reason to be confused. First you had the astounding bull market of the 1990s. Then, earlier this decade, the markets were ravaged. Now the good times appear to have returned. But how does one know if the recent run-ups in stockmarkets are a sign of a return to better times, or merely a momentary upturn in an otherwise long-term bear run?

At times like this, the savvy investor needs to look through the fog of contradictory advice and return to fundamentals. Invest for the longer term. Be prepared to accept that there may be occasional volatility. Look for companies with good prospects and sound managements. Understand the companies you invest in, and, above all else, build a diversified portfolio.

Within that portfolio, there is a strong case for allocating some funds to smaller companies. A recent study of long-term investment returns concluded that, over the past 50 years, micro-cap equities have outperformed small-cap equities, which in turn did better than large-cap equities.

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However, the regulators limit the opportunities for private investors to put their money into small firms. Some of the reasons for this are valid - their share prices can be more volatile than those of larger companies and their shares illiquid. But some are less valid - the idea that large firms must naturally be safer, for instance. Try telling that to investors in once-high-flying companies like Marconi.

That said, to its credit the Government has recently changed the rules for venture capital trusts, which can invest in the Aim market and unquoted companies. If you invest in these for the next tax year, you will enjoy 40% income-tax relief.

Sceptics may point out that VCTs have not been a good investment historically, and it is all too true that recent years have been disappointing, but that's true for almost all investments.

A VCT can be a very good bet if you find a VCT manager who understands long-term investing, ie, one who will build a diversified portfolio that includes a spread of sectors as well as Aim companies, pre-Aim companies and some smaller management buy-outs and buy-ins. The latter can show strong growth once freed from the shackles of their former ownership and are more likely to be acquired by larger companies than to float on the stockmarket.

Investors should also look for a manager who is committed to paying out tax-free dividends as quickly as possible and who is prepared to provide a share buy-back facility to increase liquidity.

VCTs are listed on the main London stockmarket, but because investors tend to be long-term holders of their shares, they tend to be illiquid. A 40% tax break is certainly not a reason to make any investment, but if you find a good fund, its attractions will certainly be enhanced by the tax break.

Two stocks we are currently holding are Dunn-Line (DUN) and XN CheckoutHoldings (XNC). Dunn-Line offers local and school bus services in the Midlandsand is a subcontractor for National Express. It has recently undergone considerable restructuring, changing from a spot-hire coach company to a provider of scheduled bus services. Today, about 75% of turnover is on a long-term contract basis.

XN provides electronic point of sale (EPOS) systems to the leisure sector. The firm has more than 40,000 installed systems at 4,000 sites and is chaired by former Torex chief executive, Chris Moore, who has made a substantial personal investment in the company.